There has been a substantial increase, since 2004, in the number of firms that announce annual earnings before audit completion as opposed to after audit completion. In this study, we argue that earnings announced before audit completion are associated with lower financial reporting quality and investor perceptions that earnings are more likely to be overstated. Consistent with this expectation, we document that the market places more (less) weight on good (bad) earnings news for earnings announced after audit completion relative to earnings announced before audit completion. We continue to find this differential market response when we expand the returns window to include the 10‐K filing date, suggesting that the differential response is not driven by investors' temporary concerns about earnings revisions between the earnings announcement and the 10‐K filing date or by differential GAAP disclosures in the earnings announcement, as suggested in prior research. Finally, as a direct test of financial reporting quality, we show that earnings announced with a completed audit are less likely to be restated in the future, are less likely to meet or beat expectations, and are associated with fewer income‐increasing discretionary accruals than those announced with an incomplete audit.
Research Summary
Violation severity represents an important contextual factor in explaining the extent to which top actor performance is a benefit or burden following a negative event. Research often conflates how observers perceive an event with its objective severity, however, while ignoring the potential divergence between both types. We therefore introduce the severity gap, which reflects the degree to which perceived and objective violation severity diverge, and we theorize about how it informs the degree to which top actor performance offers benefits or burdens for these actors. We hypothesize and find that internal stakeholders shield strong performing top actors when the severity gap is high, but that performance is less salient to external stakeholders who distance themselves from these top actors.
Managerial Summary
Organizations embroiled in violations are often subject to formal assessments of the severity of the event as well as the court of public opinion. Yet researchers have largely conceptualized objective and perceived violation severity as mirrors of each another. We question if this captures what actually unfolds in the marketplace, particularly given the myriad examples of when violations resonate more strongly with observers than the objective severity would suggest, or vice versa. We examine how the gap between perceived and objective violation severity influences how much insiders and outsiders are concerned with top actor performance when considering which outcomes top actors encounter after the negative event. Our results suggest that insiders shield top performers as the severity gap increases, but that outsiders remain increasingly skeptical.
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